Ethiopia’s Security Dilemma

While most banks in Africa are fine-tuning their systems to prevent fraud and other criminal activities, Ethiopia’s banking system is only now moving into the 21st-century electronic stage. Will this move into modernisation compromise banking security?

Ethiopia’s millennium may have arrived seven years late due to calendar differences, but its banks are set to reach the 21st century only in 2011, as the country moves to modern and less risky computerised payment systems to support its economic boom.

Already the fifth-biggest economy in sub-Saharan Africa, Ethiopia has been averaging double-digit growth in real Gross Domestic Product (GDP). The government aims to keep this up for the foreseeable future in order to boost living standards for a population of 80m, Africa’s second most numerous.

But growth has been partly constrained by a creaky financial infrastructure. The financial sector consists of banks (deposit-taking institutions), insurance companies, micro-finance institutions, savings and credit cooperatives and some pension and provident funds.

Private banking re-emerged in 1996, after nationalisation in the 1970s and decades of state-run banking. The first of the new private banks was a new Bank of Abyssinia, launched 90 years to the day after Emperor Menelik II inaugurated a bank of the same name in 1906 and began formal banking in the country.

At the time of writing in late 2010, there were three state-owned banks, of which the government-owned Commercial Bank of Ethiopia (CBE) still controls the majority of the market, and 13 registered private banks.

Many of the banks had been launched after initial public offerings of shares to raise the share capital from an Ethiopian public – by law, banks must be 100% Ethiopian-owned – seeking sanctuary for their savings from storms of inflation. Surfing the IPO flood, another eight private banks were raising capital from the public and aiming to start operations in 2011.

Despite the growth, modernisation has been slow, partly due to a block on foreign ownership of financial institutions. One effect is that many bank managers and directors gained all their banking experience in Ethiopia, often trained at CBE.

In addition, the National Bank of Ethiopia (NBE), keeps a close eye, as it is the central bank and regulator. Innovations, which may be seen as potentially risky, may be rigorously examined, with a delaying effect on the time to market for a new product or service.

Cash is still king

As a result, cash is still king in Ethiopia. Cheques, carried by messenger from bank to bank for clearance, come second. The Addis Ababa Clearing House (AACH) cleared Birr 26bn ($1.5bn) of cheque transactions in 2008, according to the NBE.

There are no transaction-clearing facilities outside the capital, which increases the risk, delays, difficulty and cost of using cheques anywhere else in the country. Even in Addis, government institutions such as Ethiopian Telecommunications Corporation and local government offices see long queues each month as all their customers come to settle bills in cash.

Although Automated Teller Machines (ATMs) and Point-of-Sale (POS) terminals were introduced more than five years ago, banks have been fairly slow to roll them out. However, three groups of banks have separately agreed to work together on setting up pools of combined ATM/POS hardware.

Credit transfers between banks’ operating accounts at the NBE are done using the NBE’s Bank Master system, supplied by MiSys. Transactions are input manually at the NBE on instruction by the paying banks.

The NBE also does Open Market Operations, including issuing treasury bills at 15-day intervals. Sometimes bonds are also issued, for instance with tenure of 10 years, but secondary trading of government paper is almost non-existent. Banks have to hold 15% of their deposits as cash reserves.

In 2009, the National Bank started work on a National Payment System (NPS), inviting bidders to apply. The aim, according to background documentation, is that the system will play “a critical role in facilitating commercial activity, economic growth and the ability of the country to participate in global commerce.

“The main goals are to develop a safe, efficient and reliable infrastructure for payments and securities settlement which will support the emerging financial markets, enhance the effectiveness of monetary policy and broad access of the public to financial services through the provision of efficient, affordable retail payment instruments.”

The automated transfer system (ATS) is to include two sections but one lead supplier in a single integrated system. It will include a Real-Time Gross Settlement (RTGS) system for inter-bank settlement, transferring individual funds for transactions as they happen continuously throughout the day.

The functionality is aimed particularly at large-value and time-critical payments and would also aim to reduce settlement risk, including in foreign transactions.

The second section will be an Automated Clearing House (ACH) to upgrade the retail payments infrastructure through clearing and settling cheques, cards, direct debits, credit transfers and other retail transactions. The central bank is also considering a national card switch system.

All commercial banks, private and publicly owned, will have to link to the ATS, offering straight-through processing (STP) from their ‘core banking systems’.

In most cases, this means upgrading their existing systems, which were initially often created in-house and consisted of branch-bound networks, as Ethiopia has only recently been upgrading data capabilities around Addis and fibre backbones up and down the country.

Catching up with modern systems

Up until the current round of modernisation, the majority of the Ethiopian banks were running on distributed systems they had developed themselves or acquired locally and cheaply, which were installed at each branch and handled the customers of each branch as if they were only customers at that branch, with no communication across branches. This made it difficult for a customer of one branch to be serviced even by another of the same bank.

Recently, almost all banks have been replacing their old legacy systems with tried and tested core banking solutions from the international market. Some of the functionalities expected to come into existence, so familiar in other countries, include direct credit payment instructions from customers, files of direct debit instructions from utility providers (including telecoms, power and water), bulk salary payments (currently only offered by 2-3 banks) and other high-volume payments and transactions.

A future addition will be a Central Securities Depository, initially aimed at treasury bills and government bonds, but able to be extended as Ethiopia develops its capital markets.

The aim is to follow the world trend and move away from cash and paper-based transactions, including cheques and bank payment orders, and towards electronic payments which are faster, more secure and much less costly.

The government is a major user of the banking system and currently uses cheques for most transactions, so a system which could offer opportunities to provide, for example, salary payments by electronic transfer, could be a major boost to efficiency and also bring many more customers to the banking system.

More widely, improving incomes for the poorest, including smallholder farmers who make up the bulk of the 80m population, is a priority for Ethiopia’s long-term vision of moving incomes up to the level of a middle-income country. This is one of the pillars of a strategic Growth and Transformation Plan (2010/11–2014/15) which the Ministry of Finance and Economic Development has recently been finalising.

Vendors heading for Addis

The top international vendors have been streaming into Addis for the last 18 months, making presentations and negotiating with the local banks. Two new banks have acquired Flexcube, while Infrasoft has signed deals with three banks and two MFIs in the last year, and Temenos, which previously had one customer, has added two more in the last year. Misys is used by two banks and the NBE, but the major government-owned Commercial Bank of Ethiopia is moving to a new system.

According to Amaha Bekele, IT Partner in Ethiopia and head of IT Advisory for East Africa at Ernst & Young, which is part of the consortium implementing the NPS: “With core banking systems implemented, banks can route their bank-to-bank transactions from any branch to any branch, centrally through the core banking system with an interface to the national payment system.”

The challenge for banks is to upgrade their core banking systems, which are the heart of all the systems running in a bank and form the core of their IT platforms. Core banking systems provide the banks with their customer information management, different products or services such as savings, deposits, current accounts, loans and overdrafts, trade finance, foreign exchange, and others, as well as their most fundamental processes, the central accounting and the transaction-processing functions.

Modern core systems offer more functions and give banks an integrated solution for most of their operations. They are installed centrally in banks’ data centres and can be accessed by all branches, as long as the banks have set up a wide area network connection between their branches.

For banks to be part of the initial batch of banks that go “live” with STP connection with the ATS, they would have to be ready with their core banking project, including the interfaces with the ATS, by early March 2011 for pilot runs.

Compliance and regulation already includes a Financial Intelligence Centre and all the banks already had regular online reporting to the NBE, which measures non-performing loans, deposits, credit exposures and ratios, among other risk measures.

Links to the outside world are largely through SWIFT, and the new national networks will also support and monitor this. Branches anywhere in the country will be able to connect and transmit, and this will be an important boost for regional development, as Ethiopia is a federation of regional states.

The new systems will herald the 21st century of banking services, including Internet banking and mobile money. Comments Amaha Bekele: “Most of the advanced core banking systems are easily configurable, allowing bankers to create new products and services based on market feedback as well as based on customer segmentation using basic key parameters.

“For example, banks will be able to create various types of saving and loan accounts and to mix and match across the products on offer using labels such as ‘premier accounts’ and ‘under-18 accounts’ with simplicity. Delivering phone, SMS and Internet banking will use the same integrated solution within an overall security framework, making it very secure and easy to manage.”

Ethiopian banking is moving to a new era with the roll-out of core banking solutions and integrating them to the ATS. It is important that the banks realise the impacts of this and react by transforming current relatively rudimentary banking processes so that they are be competitive in a new financial sector.

The silver linings also bring clouds, as Amaha Bekele warns: “The new environment will also be highly susceptible to fraud and theft. Our experience in the region highlights that a high percentage of the reported banking frauds relate to electronic transfers through RTGS, SWIFT and other systems.

“The instantaneous and rapid nature of these transactions makes the systems susceptible to fraud attacks. As a result, for example, the Kenyan central bank in 2010 requested all commercial banks to have their interface to the RTGS system security-audited by an independent body on an annual basis. We have also seen huge demands from banks in the region around core banking implementation support, security assessments, penetration testing and fraud investigation.”

Fast, cost-effective and efficient payment systems are likely to be vital as Ethiopia continues to boom, and to hold its place as one of the fastest-growing and most important economies in a dynamic continent. As in the rest of Africa, many will be quick to move on to new technology and the growth of the financial sector is likely to be huge as it starts to modernise and usurp cash from its throne. Transaction volumes should increase rapidly, both in size and quantity. Systems will need to be robust to cope with huge growth, as already seen in other sectors of the economy.

At the same time, the payment system and the banks’ core banking are expected to lay a secure platform, for more economic excitement and change can be expected in years ahead.